Fixed Income Boutique

Flexible Bonds, outlook and positioning

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Ludovic Colin

Head of Global Flexible Bonds, Senior Portfolio Manager


Market Update

  • Right now, the market is pricing in a very positive recovery, in our view. The market is also trying to assess how long and how strong a recovery would be.
  • Fiscal and monetary stimulus is in play and budget deficits will grow. How sustainable this new wave of debt creation is, and how long governments and central banks will be able to keep the wheel spinning is a key question. The answer, in our view, is that at least for the time being this is not a reason for concern. The blueprint for other developed markets will likely be Japan and its ability at managing large debt loads for nearly a quarter of a century.
  • Our view is that, as we get nearer to the summer and since economies are opening up, we are beginning to see light at the end of the tunnel.
  • We are cautiously optimistic about the market. Higher quality investment-grade credit and equities have had a positive run and already appear to us as if, in some cases, they are getting a bit ahead of themselves. This indicates to us that investor confidence is returning and this positive performance should spread to lower investment grade, high yield, and emerging market bonds.

Portfolio Positioning

  • We are attempting to take advantage of relative-value trades, for example, those from the same issuer with bonds denominated in different currencies.
  • We have been active in the primary market, which is again working well compared to the secondary market. However, we have seen instances (Pepsi-Cola, for example), where the primary premium no longer offers a new issuance premium. This could move investors towards the secondary market again, which would be another welcome step in market normalization.
  • In Europe, we think there is room still for further recovery, particularly in financials.
  • We have been active in investment grade during the past three weeks, and are now turning our sights tentatively to opportunities available in high yield and some sovereign/corporate emerging markets, where we feel there is value to be found. But here we are going in from a very granular level, looking carefully at each individual name on offer and what to buy. For example, currently, the CDX Investment Grade US Index, which contains 100 names, has a spread of around 90 basis points. If you remove the 10 names with the widest spreads, the spread of the remaining 90 falls to a little above 40bps. This tells us that there are still names with hefty spreads in the investment-grade space, but also that the highest quality names have tightened to nearly the levels seen before the market meltdown. All in all, we feel that with careful selection, there is still very good yield to be extracted.
  • We aim to be fully diversified. We maintain just over a third of our ex-ante risk in FX, under a third in duration and government bonds, and around 40% in spreads, which are evenly split between developed and emerging markets – the majority of the emerging market risk is in hard-currency sovereigns.
  • Yield-to-maturity is 6% in EUR, with carry at 5.5% EUR, and the average rating of the portfolio is BBB+
  • We have increased the granularity of the portfolio from around 180 names during the crisis to 196 names currently. This is in line with the above-mentioned policy to maintain diversification.
  • The duration of the portfolio is just below 5 years. However, here we have been very active, going as low as 4.7 and then up to 5.5 during the past three weeks. We see lots of opportunities in duration and, therefore, remain fluid and active in this space.
  • We are overweight US and underweight Germany.
  • We are exposed to developed market banks and insurance. We have peripheral debt and both emerging market sovereigns and corporates. Less than 3% in energy and less than 2% high-yield developed corporates.
  • In FX, we have decreased the risk in FX derivatives. We remain short USD, long EUR and JPY. We have a short in cyclical currencies such as CAD and AUD and are long NOK. We have now recovered around 65% of the maximum loss we had in the derivatives and hope that we can recover to 85-90% from our maximum drawdown.
  • In our view, VIX remains too high and CDS are too expensive.

Outlook

  • The market is far more resilient now compared to March
  • As developed market yields remain near zero then the only variable of adjustment will be currencies, in our view. Therefore, going forward, currencies will act as an indicator of how the markets trust a specific country – meaning the government debt and central bank behind the currency. This may result in currency wars going forward.
  • We think opportunities are now out there. Little by little, we should see growing interest in lower investment grade, high yield, and quality emerging market debt.
  • As the world begins to open up again, we’re cautiously optimistic, particularly in the markets that were not shocked by the recent oil price meltdown.
  • We see the primary market is alive and kicking, but it’s going to be harder going forward for this market, in our view.

For further information on performance and investment considerations regarding funds included in this Insight, please click on the respective "Related Funds" below.



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